Auto Ancillary #7

To continue further on speculation in my previous post, let me tell you how important it is also to become an informed investor.

It’s among those profitable companies where you should truly start to think like an owner of a business rather than a renter of pieces of paper that are represented by wiggles on a screen in some broker’s office. And it’s here you will find extraordinary businesses at the bargain price.

If you ask me, the best long term risk adjusted returns come from buying exceptional businesses and holding them for as long as they remain exceptional, continue to have bright prospects for intrinsic value growth and share price do not diverge too far above forecast intrinsic values.

Have always believed that to sustain equity investments success requires two core skills and right temperament – the latter is up to you and your parents. The two core skills are the ability to identify a superior business and the ability to value that business.

Many investment studies have shown that asset allocation is also a meaningful driver of overall investment returns but my view is also that top –down approach has few errors from which little can be learned on what to include or exclude for investments. But, the ability to value businesses produces a list of those that are expensive and those that are cheap. When the vast majority of companies are expensive and only few are available at bargain price, then the conclusion is that more funds must be allocated to cash. In other words, a bottom –up approach, such as the one contemplated here, produces the only sensible asset allocation.

Below is the list of businesses and their Value Operations grading that we will look for investments. Value Operations quality & performance ratings are not forward looking, it means they represent how business performed last year (performance rating) and quality of this business Balance sheet (Quality ratings) from past 5 years.

Businesses

VO Quality Ratings

Amar Raja Batteries

A1

Amtek Auto

B3

Amtek India

B3

Asahi India Glass

C4

Autoline Industries

C3

Automotive Axles

B2

Bosch

A2

Exide Industries

B3

Federal-Mogul Goetze

C2

Gabriel India

C2

Motherson Sumi System

B3

Shanthi Gears

B2

Wabco India

A2

Over here we also look at the businesses whose quality ratings are at the borders to our investment grade (B2 & A3), to look if there is any room for change in their performance.

There is a reason why we are not looking at the other businesses and you will understand when you start thinking like a business owners.

Businesses

Contribution of Shareholders (Crore)

Net Profits (Crore)

ROE

Amar Raja Batteries

Rs 1,060 crore

Rs 287 crore

30%

Amtek Auto

Rs 6,176 crore

Rs 697 crore

12%

Amtek India

Rs 2017 crore

Rs 156 crore

8%

Asahi India Glass

Rs 40 crore

-Rs 99 crore

n/a

Autoline Industries

Rs 279 crore

Rs 11 crore

4%

Automotive Axles

Rs 271 crore

Rs 45 crore

17%

Bosch

Rs 5,573 crore

Rs 958 crore

19%

Exide Industries

Rs 3080 crore

Rs 540 crore

19%

Federal-Mogul Goetze

Rs 411 crore

Rs 2 crore

0.50%

Gabriel India

Rs 257 crore

Rs 38 crore

16%

Motherson Sumi System

Rs 2,289 crore

Rs 470 crore

23%

Shanthi Gears

Rs 258 crore

Rs 15 crore

6%

Wabco India

Rs 649 crore

Rs 131 crore

22%

There will be definitely a question arise that why we are ignoring few businesses like Exide Industries and Motherson Sumi systems who have good numbers on the board.

Exide Industries have problems with its cash flow. They are not generating enough cash from its operations compare to its other counterpart. You would not like to own business which is just showing profits on paper but not generating enough from its operations. Motherson has issues with its debt, they have a burden of more than Rs 4,000 crore to pay.

Shanthi gears and Automotive Axles are the black horses in the list. But they unfortunately did not impressed with ‘bright prospects’ category. We do not expect the intrinsic value of Shanthi Gears to go anywhere and Automotive Axles to halve from its previous year.

Amar Raja Batteries is our favourite pick from this sector. It is India’s second biggest battery maker and behind the Exide Industries. In a lacklustre macro-economic conditions for their products, they have utilised almost 90% of their capacity. They have built a blueprint to almost double their capacity in two years by investing 7 billion rupees within their business. The good part is all of that money will come from within the business.

We are convinced with our view that Amara Raja has a ‘bright prospects’ for the coming years. Opportunities to invest in exceptional businesses at discount price comes two – four times in a year. Your returns on investments depends on what price you bought the business. The higher you pay, the lower will be your returns and lower you pay, the higher will be your returns. This is the simple equation of your returns.

A week back this business fell down to Rs 211, within a day it jumped 10% and yesterdays close was Rs 255 (12th August 2013).

So what is the fair value for this business?

We at Value operations valued this business actual fair value for the year end 2013 to be Rs 168. We expect them to report their earnings for the year end 2014 to be Rs 19.72 per share which translates its expected intrinsic value to be Rs 211 per share.

We also expect its earnings for the year end 2015 to be Rs 22.07 per share, if it is true then its expected intrinsic value will be Rs 237 per share. They will be releasing their first quarter 2014 results on 14th August 2013 and that will be closely watched by us. We have always noticed that Amara Raja has beaten our expectations in the past, which we are always in favour of as it gives us sweet results.

Bosch and Wabco India are facing weak earnings growth and both are not expected to add in intrinsic values to their past.

If we would have applied top-down approach, we would have missed Amara Raja, as it is going strong against the economic tide and its peers.

In last 7 weeks we have recognised 10 businesses worth to be in our watchlist. Not all of them are trading at discount but any deterioration in their price should not stop us to invest and allocate our capital within them.

Bajaj Auto

Maruti Suzuki/Eicher Motors

Axis Bank

HDFC Bank

J&K Bank

City Union Bank

Karur Vysya Bank

Indusind Bank

Amara Raja Batteries

Let me know what you think of this list so far. Also take this list as a second opinion and do your own due-diligence before taking any investment decision because even we can be wrong on our calls.